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The great diversification and its undoing

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Abstract

We investigate the hypothesis that macroeconomic fluctuations are primitively the results of many microeconomic shocks, and show that it has significant explanatory power for the evolution of macroeconomic volatility. We define “fundamental” volatility as the volatility that would arise from an economy made entirely of idiosyncratic microeconomic shocks, occurring primitively at the level of sectors or firms. In its empirical construction, motivated by a simple model, the sales share of different sectors vary over time (in a way we directly measure), while the volatility of those sectors remains constant. We find that fundamental volatility accounts for the swings in macroeconomic volatility in the US and the other major world economies in the past half century. It accounts for the “great moderation” and its undoing. Controlling for our measure of fundamental volatility, there is no break in output volatility. The initial great moderation is due to a decreasing share of manufacturing between 1975 and 1985. The recent rise of macroeconomic volatility is due to the increase of the size of the financial sector. We provide a model to think quantitatively about the large comovement generated by idiosyncratic shocks. As the origin of aggregate shocks can be traced to identifiable microeconomic shocks, we may better understand the origins of aggregate fluctuations.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1208.

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Date of creation: Jan 2010
Date of revision: Oct 2010
Handle: RePEc:upf:upfgen:1208

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Web page: http://www.econ.upf.edu/

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  1. “The Great Diversification and Its Unraveling,” V. Carvalho and X. Gabaix (2013)
    by afinetheorem in A Fine Theorem on 2013-08-09 22:25:07
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Cited by:
  1. Torben G. Andersen & Tim Bollerslev & Peter F. Christoffersen & Francis X. Diebold, 2011. "Financial Risk Measurement for Financial Risk Management," PIER Working Paper Archive 11-037, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  2. Julian di Giovanni & Andrei A. Levchenko & Isabelle Méjean, 2013. "Firms, destinations, and aggregate fluctuations," Economics Working Papers 1387, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2014.
  3. Manjola Tase, 2013. "Sectoral allocation, risk efficiency and the Great Moderation," Finance and Economics Discussion Series 2013-73, Board of Governors of the Federal Reserve System (U.S.).
  4. Lorenzo Burlon, 2012. "How Do Aggregate Fluctuations Depend on the Network Structure of the Economy?," Working Papers in Economics 278, Universitat de Barcelona. Espai de Recerca en Economia.
  5. Pogany, Peter, 2013. "Thermodynamic Isolation and the New World Order," MPRA Paper 49924, University Library of Munich, Germany.
  6. Jonas D. M. Fisher, 2012. "Comment on "The Geography of the Great Recession"," NBER Chapters, in: NBER International Seminar on Macroeconomics 2012, pages 336-343 National Bureau of Economic Research, Inc.
  7. Giuseppe Berlingieri, 2013. "Outsourcing and the Rise in Services," CEP Discussion Papers dp1199, Centre for Economic Performance, LSE.
  8. Loris Rubini, 2013. "Growth, Structural Transformation, and Volatility," Documentos de Trabajo 444, Instituto de Economia. Pontificia Universidad Católica de Chile..
  9. Daron Acemoglu & Vasco Carvalho & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2011. "The network origins of aggregate fluctuations," Economics Working Papers 1291, Department of Economics and Business, Universitat Pompeu Fabra.
  10. Baran Doda, 2012. "Evidence on CO2 emissions and business cycles," Grantham Research Institute on Climate Change and the Environment Working Papers 78, Grantham Research Institute on Climate Change and the Environment.
  11. Constant Lonkeng Ngouana, 2013. "Structural Transformation and the Volatility of Aggregate Output in OECD Countries," IMF Working Papers 13/43, International Monetary Fund.
  12. Cristiano Cantore & Filippo Ferroni & Miguel A. León-Ledesma, 2012. "The dynamics of hours worked and technology," Banco de Espa�a Working Papers 1238, Banco de Espa�a.
  13. Cantore, C. & Ferroni, F. & León-Ledesma, M A., 2011. "Interpreting the Hours-Technology time-varying relationship," Working papers 351, Banque de France.
  14. Jan Grobovsek (University of Edinburgh), 2013. "Development Accounting with Intermediate Goods," ESE Discussion Papers 223, Edinburgh School of Economics, University of Edinburgh.

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